Transfer Pricing in International Business: A Management Tool for Adding Value
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For example, Party A manufactures zips for business bags and briefcases to be sold by companies around the world. Party A sells the product to Party B, which is an associated company in another country. From this transaction with Party B, Party A earns a gross profit markup.
Transfer Pricing - Purpose & Methodologies
Party A does not include operating expenses in the cost of the product. Party C and Party D are independent enterprises that manufacture zip mechanisms for coats. They sell their products to independent clothing brands and also earn a gross profit markup for the transaction. Party C and Party D include operating expenses in the cost of their products. These types of methods assess the profits from particular controlled transactions. The OECD states that, in order to be accurate, the taxpayer should use the same net profit indicator that they would apply in comparable uncontrolled transactions.
Taxpayer can use comparables data to find the net margin that would have been earned by independent enterprises in comparable transactions. The taxpayer also needs to carry out a functional analysis of the transactions to assess their comparability. If an adjustment is needed for a gross profit markup to be comparable, but the information on the relevant costs are not available, then taxpayers can use the net profit method and indicators to assess the transaction.
This approach can be taken when the functions performed by comparable entities are slightly different.
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For example, an independent enterprise offers technical support for the sale of a piece of IT equipment. The cost of the support is included in the price of the product but cannot be easily separated from it. So, the gross margins of the transactions are not comparable. By examining net margins, associated enterprises can more easily identify the difference in transfer pricing in relation to the functions performed. The second transactional profit method outlined by the OECD is the transactional profit split method.
It focuses on highlighting how profits and indeed losses would have been divided within independent enterprises in comparable transactions. It starts by determining the profits from the controlled transactions that are to be split.
The profits are then split between the associated enterprises according to how they would have been divided between independent enterprises in a comparable uncontrolled transaction. These are the five transfer pricing methods, and the ones favored by the OECD. The option that an organization chooses to use depends on the particular situation. It should take into account the amount of relevant comparables data that is available, the level of comparability of the uncontrolled and controlled transactions in question, and whether a method is appropriate for the nature of a particular transaction determined through a functional analysis.
Our databases allow organizations to find high-quality comparables data to apply transfer pricing methods outlined above. Contact us at RoyaltyRange to find out more. You can use this text with reference to RoyaltyRange website. Blog Transfer pricing methods. Transfer pricing methods Article — December RoyaltyRange. Asta Rudzikiene, Director. Resale price method Another traditional transaction method for determining transfer pricing is the resale price method. Cost plus method The cost plus method is a traditional transaction method that analyzes a controlled transaction between an associated supplier and purchaser.
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Control with Fairness in Transfer Pricing
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